Japanese Capital Spending rose by greater than expected 13.8% while the Shanghai stock index plunged by more than 8% breaking the key 3700 support trend line. Yet neither the positive economic news nor the increase in risk aversion helped the yen which stubbornly remained above the 122.00 barrier. For the time being traders continue to view the Shanghai declines as mere corrections of an up trend since a similarly sharp sell off at the end of February was recouped within 5 weeks. However, the sense of complacency in the currency market may quickly evaporate if the Shanghai decline continues unabated especially in light of the fact that Chinese authorities are now discussing the imposition of new capital gains taxes in order to slow down the parabolic advance of the stock market. If the Shanghai index does not quickly recover its losses, USDJPY could start to drop in a delayed reaction as fears of contraction in liquidity sweep through the market. With little economic news on the Japanese calendar, the price action of the Shanghai stock market could set the direction for the currency for the rest of this week.

In other Asia Pacific news, Australia continues to rack up very impressive numbers as ANZ Job Advertisements climbed 10.3% while Company Operating profits for Q1 rose a far better than forecast 7.6%. Both pieces of data suggest that the Australian GDP release due on Wednesday at 1:30 GMT which could surprise the upside. The Aussie did little in tonight’s session, but if the economic news later in the week proves stronger than expected market players will begin to price in yet another rate hike from the RBA and the unit could well challenge the 8400 level.

Meanwhile in Europe, the euro held in its now familiar range around the 1.3450 level as traders squared their position ahead of the ECB meeting and rate announcement on Wednesday. Given the paucity of data on the US side the ECB press conference is likely to be the critical event risk of the week. While there is almost a universal expectation of a hike to 4%, the far more interesting question for traders is whether the ECB is willing to go further in its tightening campaign. While the eco data from the EZ has been relatively good, we believe that EZ monetary officials will take a wait and see attitude for the rest of the of the summer before considering any additional action.

Finally, the pound saw the biggest action of the night as early buy orders from Germany pushed the pair above 1.9850. The strength in cable however, was not caused by any particular good news on the economic front (Construction PMI dropped to 58 from 59.5 projected), but rather by a bevy of M&A activity including RBS expected sale of Southern Water for 4 Billion GBP. As such, the news is likely to have only temporary effect on pound price action.

Boris Schlossberg is a Senior Currency Strategist at FXCM.